“The 2013 Gold Crash”

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” – Warren Buffett

Gold

The legendary investor is known for his antagonistic take on gold as an investment option. But there is no denying the unmatched popularity of the yellow metal from historical times given its sheen and value. Investors have bought gold as a hedge against inflation or a safeguard against the collapse of paper assets.

Gold ETFs (Exchange Traded Funds) have also become very popular as an investment option. Gold’s attributes like malleability, resistance to corrosion or tarnishing, and shine make it ideal for jewelry. And so long as vanity exists, can jewelry ever go out of fashion?

However, gold has lately fallen from grace as an investment option. The words of Buffet never rang so true.

The “Golden” Days

The global financial crisis of 2008 severely hit investors’ confidence in conventional paper assets, making gold an attractive alternative. This led gold prices soaring to an all time high of $1,900 per ounce in Aug 2011. In 2012, gold’s average market price of $1,669 per ounce hit an all-time record high, taking advantage of a weak dollar, lingering concerns over Europe’s financial problems, China’s reduced economic growth numbers and announcement of the third round of quantitative easing (QE3).

2013: A Nightmare Year for Gold

Highlights: Alarming Drop in April; Lowest Price in Three Years in June and Came Close in December, Ends 2013 at around $1,200 per ounce

2013 was an unlucky year for gold as it suffered a 28% drop, ending the year at around $1,200 per ounce – the worst slump in more than three decades. It was not one event that affected the gold market in 2013. A multitude of factors – the Federal Reserve’s taper or no taper confusion, conflict in Syria and the U.S. government‘s partial shutdown, and finally the taper call at year end – pushed gold prices downhill through the year.

Gold plunged 9% in one day to $1,395 per ounce on Apr 12 – the biggest loss in one day — on the news that Cyprus would sell gold from its reserves. This led investors to offload their positions. In June, reports that the Fed was contemplating tapering its $85 billion of bond purchases sent gold prices reeling to the 2013 nadir of $1,192 per ounce on Jun 28 – the level last seen in Aug 2010.

In late August, gold prices trended higher as it regained its status as a safe investment hedge amid fears surrounding a possible U.S.-led military attack on Syria. As the military intervention in Syria was avoided, traders offloaded their positions, leading to a subsequent drop in September. The Federal Reserve’s unexpected announcement on Sep 18 that it will not taper resulted in a 5% surge in a day on Sep 19, marking the maximum gain for the year.

However, gold prices again continued to fall during the U.S Government shutdown. This confused gold traders as it did not drive safe-haven bids as normally expected. Finally, the Fed’s announcement of a $10 billion cut in its monthly bond purchases on Dec 18 prompted a huge sell-off which pushed gold prices down to $1,105 per ounce, the strongest negative reaction for gold since June. Gold exited 2013 at around $1,200 per ounce.

Demand Dynamics

As per the latest published data from the World Gold Council, total gold demand in the first three quarters of 2013 declined 12% to 4,373 tons, as substantial net outflow from gold ETFs offset demand for jewelry, bars and coins. Jewelry demand soared 20% and demand for gold bars and coins also went up 36% year over year, mainly driven by China and India. Jewelry demand in the U.S. has been strong over the first three quarters of 2013 after a gap of eight years, fueled by positive signs of a recovery and lower prices.

Central banks remained the primary purchasers of gold, albeit at a slower rate, purchasing net 297 tons in the period, accounting for around 9% of total gold demand. On the contrary, the first three quarters of 2013 witnessed a 697 tons net outflow from gold ETFs. The major impact was felt in the second quarter with a record outflow of 402 tons as gold prices fell sharply.

The difference between investors at the retail and the investment level was never so apparent. Retail investors (in gold bars and coins) view gold for preserving wealth and hedging against inflation over the long term. Thus, in 2013, demand from retail investors leaped to unprecedented levels as they saw an opportunity to add to their holdings as gold prices dipped.

On the other hand, the institutional investors have a short-term, speculative approach. Expectations of the U.S. government tapering quantitative easing led to ETF investors losing confidence in gold as a safe haven. The price drop prompted opportunistic investors to sell their ETF holdings and shift to other investment options. During the year, the U.S. stock market was on fire and investors flocked to equities shunning gold.

Supply

Mine production in the first three quarters was at 2,188 tons, up 3% year over year. This is a marked improvement, as production in 2012 was restrained by labor disruptions, operational issues, delayed project start-ups and expansions. China topped the list followed by Dominican Republic, Brazil, Canada and Australia.

Recycling of gold contributed 1,047 tons to the total supply, 13% lower year over year. The drop in gold prices led to a decline in recycling activity as consumers are less inclined to part with their stocks at lower prices. Recycling activity has declined in the past six consecutive quarters. Overall, gold supply dipped 4% to 3,196 tons in the first three quarters of 2013, dragged down by lower recycling activity.

Survival Tactics

The gold companies are yet to announce their fourth quarter results. As we delve into the September-end quarterly numbers of the gold companies in our coverage — Barrick Gold Corporation (ABX), Harmony Gold Mining Company Limited (HMY), Newmont Mining Corporation (NEM), Kinross Gold Corporation (KGC), Agnico Eagle Mines Limited (AEM) and Goldcorp Inc. (GG) — we see earnings have taken a beating across the board due to the decline in average realized gold prices.

The price decline added to the woes of the industry that was already grappling with rising costs, labor issues, strikes, delays and/or the cancellation of projects. If prices fall further, margins will be constrained as the price of gold closes in on the cost per ounce of the companies.

The gold miners have decided to suspend projects, curtail their capital spending and resort to layoffs to conserve cash. The companies are actively pursuing opportunities to optimize their portfolio, including the divestiture of certain non-core or non productive assets.

Following the sale of its oil and gas unit, Barrick Energy, and three Australian mines last year, Barrick Gold announced its plans to divest the Plutonic mine and Kanowna gold mine in Western Australia over the past two months. Likewise, Newmont has entered into a deal to sell its Midas underground operation and mill

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